Hi All,
imo, this is the first post to this group Re BSC and the Fed that matches
reality. The market is frozen and something must be done.
I
didn't believe Tim when he ascribed Volkerish attributes to Benny a few weeks
ago and I don't believe him when he disses Benny now. imo, events have overtaken
him and he's doing the best he can with limited options. Give the guy a
break.
Let's just hope the Fed doesn't run out of capital before we
reach a workable response to this mess. This is what I worry about these
days.
Meanwhile, listen to the market. Wyckoff said something like "the
footsteps of giants are visible in the tape". I saw real accumulation today.
Gotta go with that. If the tape says different tomorrow, I'll change my
mind.
regards,
tbr
Timothy....what
would your response and view be in relation to what Mauldin has
said?
From: realtraders@yahoogroups.com
[mailto:realtraders@yahoogroups.com] On Behalf Of robert
pisani Sent: Tuesday, 18 March 2008 10:17 AM To:
realtraders@yahoogroups.com Subject: [RT] John Mauldin's
take on Bear Stearns
Here is John Mauldin's take on the Bear Stearns
matter.
I already have a slew of emails from people upset about
what they see as a bailout of a big bank, decrying the lack of "moral hazard."
And I can understand the sentiment, as it appears that tax-payer money may
have been used to bail out a big Wall Street bank that acted recklessly in the
subprime mortgage markets.
But that is not what has happened. This is
not a bailout. The shareholders at Bear have been essentially wiped out. Note
that a third of the shares of Bear were owned by Bear employees. Many of them
have seen a lifetime of work and savings wiped out, and their jobs may be at
risk, even if they had no connection with the actual events which caused the
crisis at Bear. Don't tell them there was no moral hazard.
For all
intents and purposes, Bear would have been bankrupt this morning. The $2 a
share offer is simply to keep Bear from having to declare bankruptcy which
would mean a long, drawn out process and would have precipitated a crisis of
unimaginable proportions. Cue the lawyers.
As I understand this
morning, JP Morgan will take a $6 billion write down, which is essentially
what they are paying for Bear. The Fed is taking $30 billion dollars in a
variety of assets. They may ultimately take a loss of a few billion dollars
over time, although they may actually make a profit. When you look at the
assets, much of it is in paper that will likely get close to par over time,
and the good paper will pay premiums mitigating the potential loss. The
problem is, as the essays below point out, no one is prepared to take that
risk today.
If it was 2005, Bear would have been allowed to collapse,
as the system back then could deal with it, as it did with REFCO. But it is
not 2005. We are in a credit crisis, a perfect storm, which is of
unprecedented proportions. If Bear had not been put into sounds hands and
provided solvency and liquidity, the credit markets would simply have frozen
this morning. As in ground to a halt. Hit the wall. The end of the world,
impossible to fathom how to get out of it type of event.
The stock
market would have crashed by 20% or more, maybe a lot more. It would have made
Black Monday in 1987 look like a picnic. We would have seen tens of trillions
of dollars wiped out in equity holdings all over the world.
As I have
been writing, the Fed gets it. Their action today is actually re-assuring. I
have been writing for a long time that they would do whatever it takes to keep
the system intact. As one of the notes below points out, this was the NY Fed
stepping in, not the FOMC. The NY Fed is responsible for market integrity, not
monetary policy, and they did their job. And you can count on other actions.
They are going to change the rules on how assets can be kept on the books of
banks. Mortgage bail-outs? Possibly. The list will grow.
Yes,
tax-payers may eventually have to cover a few billion here or there on the
Bear action. But the time to worry about moral hazard was two years ago when
the various authorities allowed institutions to make subprime loans to people
with no jobs and no income and no means to repay and then sold them to
institutions all over the world as AAA assets. And we can worry in the near
future when we will need to do a complete re-write of the rules to prevent
this from happening again.
But for now, we need to bail the water out
the boat and see if we can plug the leaks. Allowing the boat to sink is not an
option. And get this. You are in the boat, whether you realize it or not. You
and your friends and neighbors and families. Whether you are in Europe or in
Asia, you would have been hurt by a failure to act by the Fed. Everything is
connected in a globalized world. Without the actions taken by the Fed, the
soft depression that many have thought would be the eventual outcome of the
huge build-up of debt would in fact become a reality. And more quickly than
you could imagine.
As I have repeatedly said, recessions are part of
the business cycle. There is nothing we can do to prevent them. But
depressions are caused by massive policy mistakes on the part of central banks
and governments. And it would have been a massive failure indeed to let Bear
collapse. I should note that this was not just a Fed action. Both President
Bush and Secretary Paulson signed off on this.
The Fed risking a few
billion here and there to keep the boat afloat is the best trade possible
today. Their action saved trillions in losses for investors all over the
world. It is a relatively small price. If you want to be outraged, think about
the multiple billions in subsidies for ethanol and the hundreds of billions of
so-called earmarks over the past few years to build bridges to nowhere. And
think of the billions in lost tax revenue that would result from the ensuing
crisis. I repeat, this was a good trade from almost any perspective, unless
you are from the hair-shirt, cut-your-nose-off-to-spite-your-face
camp of economics.
The Fed is to be applauded for taking the actions
they did. And they may have to do it again, as there are rumors that another
major investment bank is on the ropes. I hope that is not the case, and will
not add to the rumors in print, but I am glad the Fed is there if we need
them.
It is precisely because the Fed is willing to take such actions
that I am modestly optimistic that we will "only" go through a rather longish
recession and slow recovery and not the soft depression that would happen
otherwise.
I got a very sad letter today from a lady whose
husband is in the construction business an hour from Atlanta. He has had no
work for four months and they are rapidly going through their savings. The
jobs he can get require them to spend more in gas to drive to than he would
make. He is sadly part of the construction industry which everyone knows is
taking a major hit.
But without the Fed action, that story would have
multiplied many times over, as the contagion of the debt crisis would have
spread to sectors of the economy that so far have seen only a relatively small
impact. Unemployment would have sky-rocketed over the next year and many more
families would have been devastated like the family above. It would have
touched every corner of the US and the globe.
Bailing out the big guys?
No, the Fed does not care about the big guys, and only mildly pays attention
to the stock market, despite what conspiracy theorists think. In the last few
years, I have had the privilege of meeting at length with a number of Fed
economists and those who have their ear. They are far more focused on the
economy, their mandates for stable inflation and keeping unemployment as
possible.
No one who owned Bear stock was protected. This was to
protect the small guys who don't even realize they were at risk. To decry this
deal means you just don't get how dire a mess we were almost in. It is all
well and good to be rich or a theoretical purist and talk about how the Fed
should let the system collapse so that we can have a "cathartic" pricing
event. Or that the Fed should just leave well enough alone. But the pain to
the little guy in the streets who did nothing wrong would simply be too much.
The Fed and other regulatory authorities leaving well enough alone is part of
the reason we are where we are. First, get the water out of the boat and fix
the leaks, and then make sure we never get here again.
And yes, I know
there are lots of implications for the dollar, commodities, markets, interest
rates, etc. But we will get into that in later letters.
For now, let's
go to the essays from my friends and then a quick note about the stock
market.
John Mauldin, Editor Outside the Box
First, from
Michael Lewitt, writing last week before the Fed bailout of Bear:
The Risks of Systemic Collapse
by Michael Lewitt
The failure of a firm of
the size and stature of Bear Stearns would be as close to an Extinction Level
Event as the world's financial markets have ever seen. Bridgewater Associates,
Inc. writes that, "...the counterparty exposures across dealers have grown so
exponentially that it is difficult to imagine any one of them failing in
isolation." While not the world's largest financial institution, Bear is a
major counterparty to virtually every important financial player in the world.
Its insolvency would effectively freeze the assets of many hedge funds and
other liquidity providers and cause the financial system to seize up. Even an
after-the-fact government bailout would do little to prevent such a meltdown
scenario since the value of all of Bear's counterparty obligations would be
thrown into question for some period of time. The resulting cascade of hedge
fund failures and financial institution write-offs in today's mark-to-market
world would be nothing less than catastrophic.
The only way to avoid
such a scenario would be for the Federal Reserve or the Treasury to step in
before the fact and engineer a merger with a larger institution. For that to
happen, the firm's management has a responsibility to the markets to work with
the authorities sufficiently in advance to arrange a private
bailout.
The risks of a systemic collapse have risen to uncomfortable
levels. The complete withdrawal of credit from the financial system has led to
a series of implosions of hedge funds and other leveraged investment vehicles.
At some point - and nobody knows when that point is - the system is not going
to be able to withstand further failures. It will not be the sheer volume of
failures that brings the system to a standstill; the system is enormous and
can sustain huge dollar losses before becoming impaired. The problem is that
the global financial system is a case study in chaos theory. This is truly a
case where a butterfly flapping its wings in West Africa could lead to a
Category Five hurricane thousands of miles away. There are an incalculable
number of derivative contracts and counterparty relationships on which the
stability of the financial system hinges. All it would take is the collapse of
the wrong firm or the wrong derivative contract at the wrong time to throw the
wrong financial institution into crisis and force the entire system into a
death spiral.
As noted above in the discussion about Bear Stearns, we
may not need the largest institution in the world to fail to cause the
calamity - it may just be a matter of something bad happening at the wrong
firm at the wrong time to trigger a systemic collapse. This is the risk
implicit in a highly leveraged financial system financed by unstable financial
structures. These scenarios may sound like the ravings of a paranoid, but we
will remind our readers that even paranoids have enemies, and the greatest
failure that investors, lenders and regulators seem to suffer from in
perpetuity is a failure of imagination. They remain incapable of imagining
that the worst can happen, and as a result they behave in a manner that keeps
that possibility alive. At some point, all of the king's horses and all of the
king's men will not be able to put Humpty Dumpty back together again. We are
not at that point yet, but we are closer than we've ever been.
The
current market collapse was the result of an abject failure to regulate the
mortgage and derivatives markets. The extent of this failure cannot be
overstated. HCM still sees great opportunities being created in assets
being sold for reasons unrelated to their underlying value. But caution must
be the byword until the system shows greater signs of stability.
And
from Bob Eisenbies of Cumberland Advisors (www.cumber.com). Bob Eisenbeis is
Cumberland's Chief Monetary Economist. Before retirement, he was the Executive
Vice President of the Federal Reserve Bank of Atlanta. He is a member of the
U.S. Shadow Financial Regulatory Committee and a veteran of many FOMC
meetings.
The Fed Will Do What It Takes!!
By Bob Eisenbeis, Cumberland Advisors
In a
stunning announcement on Sunday the Federal Reserve Board of Governors
announced three steps to address the continuation of last week's financial
turmoil.
First, the Board approved a recommendation by the Federal
Reserve Bank of NY to cut the discount rate by 25 basis points to 3.25%.
Presumably it will approve similar recommendations by the other 11 Federal
Reserve Banks today.
Secondly, the Board voted to authorize the
Federal Reserve Bank of NY to create a temporary 6 month lending facility for
the 20 prime broker dealers. This enables them to pledge a wide range of
investment grade collateral for loans at the new 25 basis point penalty rate.
This takes effect today, March 17, 2008. The first transaction has been done
in Asian markets as this commentary is being released.
Finally, the
Board also ordered and also approved a $30 billion special financing to
facilitate JP Morgan's purchase of Bear Stearns Companies, Inc. Both Morgan
and Bear boards have unanimously approved the transactions. A shareholders
vote is still needed. Meanwhile, Bear Stearns is operating under the new
provisions today.
These actions demonstrate the extreme lengths, if
there was ever any doubt, that the Board of Governors are willing to go to.
There singular purpose is to prevent the collapse of a prime broker dealer and
the potential fall out to counter parties that such a collapse might entail.
The actions are important for several reasons. The new facility trumps
the recently announced Term Securities Lending Facility (TSLF) that was to go
into effect later this month on March 27th. Yesterday's action
provides direct loans to both banks and non-bank primary dealers. It is
intended to facilitate their ability to liquefy what might otherwise be
relatively illiquid assets. But it also means that the Fed is willing to take
on credit risk to broker dealers. Whether there will still be a stigma
associated with this borrowing, which would not have accompanied the borrowing
of securities through the TSLF is not known.
The new actions also
demonstrate that the perceived problems in financial markets were sufficiently
critical so as to not warrant waiting for the TSLF to go into effect later in
March. Why implementation of the TSLF wasn't accelerated is an interesting
question.
The actions also demonstrate that the so-called liquidity
problems (which this author has previously suggested may be actually solvency
issues) are mainly a problem for the prime brokers who were also the main
players in proliferating securitized debt securities based on sub-prime
mortgages and other assets. It is still a major question as to what the values
of these securities are and how much of an actual liability they represent for
the intuitions in question.
Whether those risks were real or imagined
may never really be known but we now know that too-big-to fail is still alive
and well, even in the US, and despite FDICIA. Federal Deposit Insurance
Corporation Improvement Act (FIDICIA) was enacted in 1991. FIDICIA requires
that management report annually on the quality of internal controls and that
the outside auditors attest to that control evaluation.
Finally, the
Fed has also taken the extraordinary step of helping to finance the takeover
of a private sector firm by one of the nation's largest banking organizations.
The implications of this will be explored in a future Commentaries when more
of the details become public.
What may be lost in the excitement of the
moment, as markets attempt to digest these latest actions, is that were taken
by the Board of Governors through the Federal Reserve Bank of NY to
address issues of financial stability. These were NOT actions taken by
the Federal Open Market Committee (FOMC). Their main responsibility is
the conduct of monetary policy for the country.
In other words, the
story will not end today, Monday, March 17, 2008. We will get a separate and
important assessment of the implications of these attempts to insulate the
real economy from the potential negative feedback effects of these financial
disruptions when the FOMC releases its decisions on whether and by how much to
cut the Federal Funds rate on Tuesday. Stay tuned, there is more to
come.
And one further brief note from Bob written late last
week:
It is time to stop pretending.
Since last August
the assertions regarding the turmoil in financial markets have been
characterized as a temporary liquidity problem. The problems first surfaced
last year with BNP Paribas and Bear Sterns' hedge fund collapse. More than 7
months have passed and, once again, another Bear Sterns shoe has dropped today
as it has been forced to go to the NY Fed discount window through a JP Morgan
conduit. This follows on the heels of the collapse of the Carlyle Group
sponsored hedge fund in London. For months institutions, politicians and
regulators have been in denial. Witness, for example, the proposals currently
being floated by the SEC that would enable institutions to offer alternative
"explanations" for how they value their assets. Pundits have been suggesting
that uncertainty and loss of confidence are the roots of the problem, but this
isn't the way to think about the problem.
It is time to step back and
recognize that the current situation isn't a liquidity issue and hasn't been
for some time now. Rather there is uncertainty about the underlying quality of
assets which is a solvency issue driven by a breakdown in highly leveraged
positions. Many of the special purpose entities and vehicles are comprised of
pyramids of paper assets supported by leverage whose values are now unknown.
If it were a simple liquidity problem the actions that the Federal
Reserve has taken would have dealt with the problems by now. If one doubts
this observation, think about what the Federal Reserve has done over the past
several months in an attempt to provide liquidity to those who need it. The
Federal Funds rates have been cut by 225 basis points. Significant liquidity
has been injected into markets by major central banks around the world. The
Federal Reserve created the Term Auction Facility and recently announced the
Term Security Lending Facility. These actions have had only temporary impacts
on both market sentiment and on credit spreads.
This is also not an
"animal spirits" problem but rather is the classic example of George
Akerloff's "market for lemons." Essentially what Akerloff tells us is that,
absent better information, it is rational for potential buyers of assets to
assume that the assets offered for sale are "lemons," hence the flight to
quality.
Finance theory clearly tells us that in such circumstances,
firms facing questions about their assets, which typically are manifested by
temporary problems of access to liquidity, will quickly find ways to reveal to
the market the true condition of its assets. Smart institutions have ample
mechanisms to deal with these problems - simply open up the books and show
them to potential investors. At this time there are also several actions that
the Fed should take to ease market questions about what has been happening.
First, there is a danger in anointing one institution to be the white
knight to deal with the Bear Sterns problem. Second, there is a pressing need
to provide more information and details about what the arrangements are with
JP Morgan and Bear Sterns. That means being more forthcoming with its
communications on what it is doing and why. Third, it is clear that there are
many potential buyers for troubled firms, if it is easy to see what they are
worth. This means that the Fed and Treasury should take the lead in forcing
increased transparency on the part of all institutions that might be
experiencing financial difficulties and those that are not. Finally, there
needs to be the recognition that the problems at this time are confined to
financial firms and have not contaminated the market for securities of firms
in the real sector.
And a brief follow up thought from
your humble analyst. I know my position today will be somewhat controversial
(a small understatement) to many readers, but I have never let fear of being
controversial deter me from giving you my thoughts and calls as I see
them.
As I write about 2 pm central time, the Dow is flat on a wild up
and down ride. I do not see this as a bottom. The Fed move keeps the system
together, but it does not do anything to stave off a fall in consumer
spending, a fall in home prices, the increased difficulty to get consumers
loans, falling construction, etc. which is what normally happens in a
recession (unlike the last time when consumers could borrow to maintain
spending).
I believe earnings are going to continue to disappoint in a
broad swath of companies, which will ultimately translate into lower stock
market prices. Be careful out there. There are good trades and deals
available, just not in traditional stock market index funds, in my opinion,
which I should point out could be quite wrong.
Your breathing sigh of
relief analyst,
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